Prospectus police go in hard

The proportion of companies changing their prospectuses after lodgement has almost doubled over the past three years as the corporate regulator toughens its scrutiny of initial public offerings.

The tighter scrutiny from the Australian Securities and Investments Commission comes as the $6 billion-plus QR National float draws investors back to the IPO market and the mining boom fuels speculation about another rush of small exploration floats.

About one in two prospectuses lodged in 2009 was followed by a supplementary or replacement prospectus to clarify or update information, up from one in four in 2007, ASIC data show.

Several floats this year at the smaller end of the market have privately complained about ASIC “nit-picking" their prospectuses as part of its broader crackdown on IPO disclosure documents.

Being forced by ASIC to issue supplementary or replacement prospectus to include or amend information can significantly delay IPOs, spook investors and swell offer costs.

More revisions mean investors have to track prospectuses that can be revised several times – a process the Australian Shareholders Association says needs reform.

The likelihood of prospectus revisions raises questions about whether companies should be allowed to promote their float’s original prospectus, which may need significant change, during the seven or 14-day exposure period when the regulator and market participants can comment on the document.

The biggest winners from more prospectus changes are legal and corporate advisers, with one observer describing disclosure document revisions as a “licence for lawyers to print money".

Company Profile

“ASIC has restructured the way it reviews prospectuses and put more resources into that area. We’ve applied a commercial overlay to supplement what had mostly been a legal review of IPOs," she tells The Australian Financial Review in an exclusive interview.

ASIC figures show that 910 prospectuses lodged in 2007 were followed by 249 supplementary or replacement prospectuses. In 2009, 539 prospectuses were followed by 256 revised prospectuses – a sharp increase in the proportion of lodged prospectuses requiring revision.

ASIC does not keep data on why companies publish supplementary prospectuses or separate IPO information from broader data on all prospectuses it reviews. The figures cover disclosure documents for IPOs, takeovers, schemes of arrangement and investment products.

The increase in revisions may partly be due to companies issuing multiple IPO prospectuses during the financial crisis, or for reasons unrelated to ASIC, such as companies publishing new offer dates, failure to meet minimum subscriptions, new pricing or other information. But the broad trend of ASIC requiring IPOs to improve disclosure is clear.

Anecdotally, companies floating this year have found it much harder to get their prospectuses past ASIC.

ASIC’s restructure has led to three units now scrutinising IPOs: the Corporations Group, the Emerging Mining and Resources Group (EMRG), and the Investment Managers and Superannuation Group.

“Better resourcing of EMRG, including hiring a geologist last year, has bolstered our scrutiny of mining floats," Gibson says. “And there has generally been greater focus by ASIC on exchanged traded products disclosure."

Sharply lower float volumes after 2007 have given ASIC more time to review IPOs, and perhaps prepare for much higher float volumes in the next few years if the mining boom continues and the sharemarket recovers. There were 242 floats in 2007 compared with 72 in 2008 and about 40 in 2009.

The result of ASIC’s enhanced IPO scrutiny is more consternation in the float market, especially among smaller companies that believe ASIC’s IPO approach is pedantic and unrealistic.

One chief executive of a small IPO tells the AFR that ASIC is creating more problems than it solves as it increasingly asks questions about business and market issues.

“You have people at ASIC without deep industry knowledge asking questions about your business model and strategy," says the CEO on the condition of anonymity. “ASIC should stick to legalities rather than try and second-guess directors on prospectus information."

“The quality of IPO prospectuses got out of hand in 2007," he says. “During market peaks, ASIC sometimes hides behind the line that it vets prospectuses rather than approves them. But we saw terrible problems emerge from the disclosure document for BrisConnections Units Trust, for example."

The publication of more supplementary prospectuses raises other issues, Wilson says. “There’s not enough clarity about why ASIC asks companies to change information through a supplementary prospectus. It’s very difficult for retail investors to make sense of supplementary prospectuses and compare them to the original prospectus to understand what has changed.

“I’m sure many small investors don’t even realise when or why a supplementary prospectus has been issued even though it may fundamentally change information in the original document that they are still using to make investment decisions."And CEOs of companies that are floating occasionally produce slide presentations for financial advisers that present information differently to the original prospectus. The upshot is different documents containing different information for different investors – which is not legal.

The Corporations Act requires IPO prospectuses contain all information investors and their advisers would reasonably require to make informed decisions about buying securities. ASIC can ask companies to issue a supplementary prospectus if their original prospectus includes misleading information, omits material information, does not fairly balance risks and opportunities, or is hard to read.

Many companies aggressively promote their IPOs to the media, investors and financial advisers as soon as their original prospectus is lodged with ASIC, or even before. The original prospectus, which may have several problems, can remain on their website and later be accompanied by short supplementary prospectus, which receives a fraction of the original document’s fanfare.

Companies sometimes tell

investors to read the supplementary prospectus in conjunction with the original prospectus – a confusing process that is arguably beyond many small investors who may not understand the difference between the documents.

More prospectus scrutiny comes at a difficult time for the IPO market. Dreadful market conditions for floats in the past three years have made it much harder to raise capital. Many floats had to scale back or extend their offers, and withdraw listing applications.

As companies and their advisers work harder to sell IPOs, more shareholder activism, growth in litigation funding, and the threat of shareholder class actions, is making directors acutely aware of their responsibilities when signing off on disclosure documents.

This is creating greater tension between the marketing and disclosure functions of prospectuses, and may partly explain the increase in revisions as some directors are more mindful about ensuring prospectus information is updated, to reduce their potential legal liability.

But the risk is prospectuses are increasingly filled with repetitive legal jargon and that they fail ASIC’s broad test of being clear, concise and effective, and providing investors with information they would reasonably expect to make informed decisions about buying float stock.

“Mining prospectuses have become a licence to print money for all the lawyers, geologists and other technical experts who hang off these documents," Grigor says.

“They are cumbersome, long-winded and do not readily give investors the information they need to make decisions. The whole system of mining prospectuses has been railroaded by lawyers looking to bills more hours. How many directors in this climate are going to challenge legal advice about disclosure even where that adds nothing and makes it harder to read a prospectus?"

He says key information – such as the background of directors, related-party transactions, seed funding, capital structure and the reputation of the independent geologist analysing exploration tenements – can often be hard to find in IPOs.

“Too many mining prospectuses are being engineered to say as little as possible and bury key information among legal jargon. ASIC is right to try and improve the quality of these documents."

ASIC says recurring problems in IPO prospectuses include insufficient disclosure of risks or key features of an offer; omission of key contract terms; failure to disclose the investment proposition clearly; inclusion of forward-looking statements without a reasonable basis, and; non-compliance with the Joint Ore Reserves Committee code (JORC) or VALMIN code for mining company resources and valuations.

ASIC’s Gibson says the presentation of key risks in prospectuses can be improved.

“There has been a tendency among IPOs to ‘boilerplate’ risks and provide the same list of generic risks you see in many prospectuses," Gibson says.

“There is scope to have a more relevant explanation of risks as they pertain to a company and a more balanced assessment of risks in some documents."

A bigger opportunity is improving the readability of IPO prospectuses, says Gibson. “Personally, I feel some IPO prospectuses are too long and repetitive, and at times too complex. Investors are discouraged from reading very long technical documents that might bury key information."

Gibson believes shorter IPO prospectuses with better navigation for different types of investors would make a difference. “The opportunity for companies is to produce disclosure documents that are more readable, have a better balance between marketing and disclosure, and at the same time do a better job of informing the market. There has been progress in this area, though more can be done.

“ASIC’s view is that prospectus disclosure has broadly been good for a long time. We do not see any need for a big overhaul of these documents but rather scope for continual improvement.

“Our approach in the past few years has been to provide better, rather than more, IPO scrutiny by having more people with more commercial and market experience review prospectuses and industry-focused teams.

“Ultimately it’s up to company directors to ensure the information in prospectuses is fair and accurate and gives investors the information they would expect to make informed decisions."